University of North Carolina at Chapel Hill
Master Paper (City and Regional Planning)
04 – 01 – 2014
The Government-Sponsored Enterprises:
Their Origins, Collapses, and Prospects
Yang Wu
University of North Carolina at Chapel Hill
Suggested Citation:
The Government-Sponsored Enterprises: Their Origins, Collapses, and Prospects
by
YANG WU
A Masters Project submitted to the faculty of the University of North Carolina at Chapel Hill
in partial fulfillment of the requirements for the degree of Master of City and Regional Planning
in the Department of City and Regional Planning
Chapel Hill
2014 Master of City and Regional Planning
Approved by:
Acknowledgements
First and foremost, I would like to thank all of the instructors in the Department of City and
Regional Planning who dedicated their time in guiding me and instructed me endlessly
patient when I came up with questions: Roberto G. Quercia, Yan Song, Mai Thi Nguyen,
William Rohe, Emil Malizia, Noreen McDonald, William T. Lester, Meenu Tewari, Dale
Whittington, and Myrick Howard. Thank you so much for everything.
I would like to give my special thanks to Michelle E Audette-Bauman, Daniel Hedglin and
Jordan Jones for helping me with editing my writings in my master paper.
I would like to give my special thanks to my advisor Roberto G. Quercia for all his advice and
support for the course of the year.
And finally, thanks to my family for all your love and support throughout my educational
Table of Contents
Cover Page………..1
Copyright License………...3
Acknowledgements………...4
Table of Contents………....5
Section 1: The Origins of The Government-Sponsored Enterprises………...6
Section 2: The Subprime Mortgage Crisis and The Precrisis Model of The GSEs………..11
Section 3: The Products and Roles of The GSEs………...….18
Section 4: The Conservation of The GSEs………...……...23
Section 5: The Prospects of The GSEs………..28
Section 6: Conclusion………...36
Section 1 – The Origins of The Government-Sponsored Enterprises
The Government-Sponsored Enterprises (GSEs) have a long history in the housing finance
system of the United States. For decades, they played a crucial role in establishing a solid
foundation of the secondary mortgage market, which provide liquidity, stability and
affordability to the mortgage market. Taking a step back to look at the history of the GSEs is
important to understanding the financial crisis, its causes, and lessons for the future (Federal
Housing Finance Agency Office of Inspector General).
The GSEs are the Federal National Mortgage Association (Fannie Mae), the Federal Home
Loan Mortgage Corporation (Freddie Mac), and the Federal Home Loan Bank System
(FHLBank System), which currently consists of 12 Federal Home Loan Banks (FHLBanks). All
of them are under the regulation and conservation of Federal Housing Finance Agency (FHFA)
since 2008. The paper will focus on the discussion of Fannie Mae and Freddie Mac.
Before the 1930s, the mortgage market generally consisted of short-term renewable loans.
These loans typically required high down payments, short maturities (3 to 6 years), and large
balloon payment,1 leading to a surprisingly high monthly payment that has no beneficial to
promoting homeownership. Only people with high income could afford such mortgages to
purchase a house.
The Great Depression in later years exacerbated the possibility and availability of the
extensive middle class to own a house. In response to this issue in 1932, the federal
government enacted the Federal Home Loan Bank Act (the Bank Act). The Bank Act created
the FHLBank System serves a reserve credit system to provide local lenders with readily
available, low-cost funding to finance housing, jobs, and economic growth (Federal Housing
Finance Agency Offices of Inspector General).
In 1933, the Home Owners’ Loan Act (HOLC) was signed into law. It introduced one of the
most important mortgage products that remain today – long-term, fixed-rate mortgages.
To further support housing finance, the National Housing Act was enacted in 1934. It
established Federal Housing Administrations (FHA) to offer federally backed insurance for
home mortgages made by FHA approved lenders.2 FHA insurance protected approved
lenders against losses on the mortgage they originated so that the lenders could provide
lower interest rate mortgages to borrowers.
In 1938, Fannie Mae was established as a federal government agency to purchase, hold, and
sell FHA-insured loans. By purchasing FHA-insured loans from private lenders, Fannie Mae
provided cash to the private lenders so that private lenders were able to provide more
mortgages to borrowers, creating liquidity in the mortgage market.
However, the too much financial burden Fannie Mae exerted on the Department of Housing
and Urban Development pushed forward the reorganization. The Federal National Mortgage
Association Charter Act of 1954 (Charter Act) transformed Fannie Mae from a government
agency into a public-private, mixed ownership enterprise. Fannie Mae was exempted from all
state and local taxes, except real property taxes.
In order to make Fannie Mae fully financial independence, the Housing and Urban
Development Act of 1968 (the 1968 HUD Act) reorganized Fannie Mae from a mixed
ownership corporation to a for-profit, shareholder-owned enterprise, which finally removed
Fannie Mae from the federal budget. At this point, Fannie Mae began operating as a GSE,
generating profits for shareholders while enjoying the benefits of exemption from taxation
and oversight as well as implied government backing (Alford, 2003). The 1968 HUD Act also
created the Government National Mortgage Association (Ginnie Mae). Ginnie Mae is a wholly
owned government corporation with the HUD remains today. Rather than buying, holding,
and selling mortgages on the market, Ginnie Mae only guarantees timely payment of
principal and interest payments on residential mortgage-backed securities (MBS).3
Two years later in 1970, Freddie Mac was created to expand the secondary mortgage market
and end the monopoly of Fannie Mae during the past thirty years. Fannie Mae and Freddie
Mac were authorized to buy and sell mortgages not insured or guaranteed by the federal
government. In 1971, Freddie Mac issued the first conventional loan MBS.
In the late 1970s, the emergence of the private-label MBSs-securities issued and insured by
private companies without government guarantee was the potential threat to the subprime
crisis. At that time, lacking implicit government guarantee, these private-label MBSs could
not compete with the conforming mortgages issued by Fannie Mae and Freddie Mac. Instead,
they had to concentrate on nonconforming mortgages – loans that were not conforming to
the underwriting criteria of Fannie Mae or Freddie Mac.
During the 1970s and 1980s, Fannie Mae and Freddie Mac functioned as the leading lenders
in the secondary mortgage market. They both purchased and sold mortgages on the market.
The primary difference between their business strategies lies in Freddie Mac did not hold the
purchased mortgages in its portfolio, but selling them to investors. In doing so, Freddie Mac
transferred the interest rate risks from its purchased mortgages to investors. In the contrary,
Fannie Mae was exposed to interest rate risk by issuing short-term debt – when interest rate
rose, its borrowing cost increased while its income from existing mortgages remained fixed.
The inflation and recessions of the late 1970s and early 1980s made Fannie Mae suffer from
unprofitable for many years. The viability of Fannie Mae was seriously doubted. Freddie Mac,
in contrast, remained profitable by the effective and successful transformation of the interest
rate risk to the investors.
After that period, the two GSEs’ business strategies began to converge. Fannie Mae started
securitizing mortgages in 1981 and Freddie Mac began holding mortgages in its portfolio. By
2001, the operations of the two GSEs looked virtually the same (Congressional Budget Office
From 2000 to 2007, GSEs gradually purchased larger and larger volumes of subprime
mortgages and Alt-A mortgages, 45 accumulating a ticking bomb for the subprime mortgage
crisis. In 2007 and 2008, housing prices decreased significantly, most of the subprime
mortgage and Alt-A mortgage borrowers suffered from great losses because of the increasing
interest rates and decreasing housing value. Loan delinquencies and defaults increased
significantly in a short period. Thousands of people were kicked out of their homes. The two
GSEs lost billions of dollars on their investment of the high risky mortgages. The federal
government established FHFA in June 2008, taking the two giants into conservation and
hoping to turn over the situation.
4Subprime Mortgages: A classification of mortgages with high risk of default. Borrowers are typically individuals with poor credit histories who are not able to qualify for conventional mortgages.
Subprime mortgages are often adjustable rate mortgages with high interest rate.
Section 2 – The Subprime Mortgage Crisis and The Precrisis Model of The GSEs
During the past decades, the U.S. housing finance system was so unique that it has been the
envy of the world. The GSEs have been fulfilling their mission in promoting homeownership
by providing liquidity,
stability and affordability to
the mortgage market. The
homeownership rate has
increased from
approximate 60% in 1960s
to 67% in 2009, even
though there were two
large recessions among the period (see Chart 1). At the same time, housing prices increased
rapidly (see Chart 2). From 2001 until it reached its peak in 2006, prices of single-family
homes increased by an
average of more than 12%
annually. Home price
appreciation was
accompanied by a rapid
increase in mortgage
indebtedness (Federal
Housing Finance Agency
Office of Inspector General, 2012; Federal Housing Finance Agency Offices of Inspector
General; Federal Housing Finance Agency Office of Inspector General).
Chart 1 - U.S. Homeownership Rate Since 1960
58 60 62 64 66 68 70
1960 1966 1972 1978 1984 1990 1996 2002 2008 Sources: U.S. Census Bureau, Homeownership Rate
from 1960 to 2009
Chart 2 - National Average and Median House Prices By Quarter: 2000Q1-2010Q2
$100,000 $120,000 $140,000 $160,000 $180,000 $200,000 $220,000 $240,000 $260,000 $280,000
Sources: FHFA, Quarterly Average and Median Prices for States and U.S.: 2000Q1-2010Q2
Subprime mortgages were loaned extensively to people with poor credit history and people
may not have had the ability to pay back the loans and people cannot undertake the
increasing interest rate risk.
From 2001 to 2006, the
subprime mortgage share
of the entire mortgage
market tripled from 7.4%
to 23.5% (see Chart 3). In
2006, there were $600
billion of subprime
mortgages issued. The ever-increasing subprime mortgage provided great accessibility for
mortgage borrowers to
purchase homes, regardless
of their income documents,
credit history and
motivations. The escalation
of housing prices and
mortgage indebtedness
jeopardized the housing
market. Finally, when the housing price began to plummet in the third quarter of 2006, the
housing market collapsed. During the following two years, home prices decreased at least
25%. Consequently, delinquency rate and foreclosure rate rapidly increased (see Chart 4 Chart 3 –Subprime Mortgage Share of
The Entire Mortgage Market
9.5% 10.6% 9.8% 10.4% 10.1%
7.6% 7.4% 8.3%
20.9% 22.7% 23.5%
9.2% 1.7% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0%
Sources: Inside Mortgage Finance
Chart 4 - Mortgage Delinquency Rate
2.3 2.3 2.3 2.4 2.9 4.3 6.5 6.5
11.9 10.8 10.8 12.3 15.6
19.9
25.5 25.9
0 5 10 15 20 25 30
2000 2004 2005 2006 2007 2008 2009 2010
Sources: Mortgage Bankers Association of America, Washington, DC
and Chart 5). Subprime
mortgages had a much
higher delinquency rate
and foreclosure rate
compared to prime
mortgages. And the
difference continuously enlarged since 2005. During the housing bubble, the delinquency
rate and foreclosure rate of subprime mortgage borrowers were extremely high, reaching a
25.9% delinquency rate and a 15.1% foreclosure rate. Subprime mortgages kicked thousands
of people out of their homes, leaving the housing market and macroeconomic heavily
wounded. Some borrowers were unable to pay back their loans because they were unable to
afford the increasing interest rate. Some borrowers strategically chose to foreclose because
of the depreciation of the housing value. Banks and private lenders lost their business as the
delinquency went up and economy went down. Fannie Mae and Freddie Mac, as the top two
largest financial institutions concentrating in mortgage finance, were also unable to cover
their losses when the subprime mortgage crisis burst. In contrast, both Fannie Mae and
Freddie Mac had continuously increased their purchasing of the nonprime mortgages before
the housing bubble and subprime mortgage crisis (see Table 1). In the private-label market,
the combined subprime mortgage share of Fannie Mae and Freddie Mac reached 82.6% in
2007. The unbelievable number undoubtedly shakes and even overturns the precrisis
business model behind the two GSEs.6 What has made the two GSEs deviate so far from their
6Precrisis business model: The model under which the two government-sponsored enterprises operated before federal conservatorship.
Chart 5 - Foreclosure Rate
0.4 0.5 0.4 0.5 1.0 1.9
3.0 3.5 9.4
3.8 3.3 4.5 8.7
13.7 15.1 14.5
0 2 4 6 8 10 12 14 16
2000 2005 2007 2009
traditional mortgage securities and guarantees?
Table 1 – Subprime Mortgage and Alt-A Mortgage Share in Private-label Market
Fannie Mae Freddie Mac Total
Year Subprime Alt-A Subprime Alt-A Subprime Alt-A
2000 5.09% 6.90% 13.87% 9.01% 18.97% 15.91%
2001 7.54% 1.35% 23.09% 10.06% 30.62% 11.41%
2002 4.51% 3.03% 33.18% 15.38% 37.69% 18.41%
2003 12.24% 8.14% 20.93% 10.41% 33.17% 18.55%
2004 19.17% 9.04% 22.06% 7.46% 41.23% 16.50%
2005 5.37% 3.82% 25.16% 6.41% 30.52% 10.23%
2006 9.43% 2.78% 19.80% 7.09% 29.23% 9.86%
2007 22.12% 3.21% 60.48% 6.07% 82.60% 9.28%
Source: GAO Analysis of Loan Performance data, FHFA, Enterprise Credit Supplements
The GSEs’ mission has changed over time. Never in history have Fannie Mae and Freddie Mac
put the taxpayers’ money into such huge risks when the two GSEs began purchasing more
and more nonprime mortgages. The precrisis business model of the two GSEs suffers from
great weaknesses (see Figure 1).
First of all, an implicit federal guarantee of the two GSEs impedes the healthy development of
a fully competitive market. When Freddie Mac was first created in 1970, on one hand, it was
created to further support the secondary mortgage market; on the other hand, policy makers
hoped it could end the monopoly of Fannie Mae during the past three decades. However, the
federal government made great mistake of guaranteeing Freddie Mac’s business just as it did
to Fannie Mae. This movement did not end the monopoly of Fannie Mae; in contrast, it
reinforced the two GSEs even stronger giants, especially when they
began to converge their business after 1980s. The federal government’s implicit guarantee of
the two GSEs forced many private lenders and small companies to get out of the mortgage
market. The GSEs were able to acquire a substantial degree of market power, which in turn
increased risk to the overall financial system; the entities had an incentive to take excessive
risks; and the costs and risks to taxpayers and the economy were not apparent in the federal
budget (Congressional Budget Office Financial Analysis Division, 2010).
In the next place, the public-private model makes Fannie Mae and Freddie Mac a paradox.
The 1968 HUD Act removed Fannie Mae’s financial status from federal budget, making it a for
profit, shareholder-owned enterprise. For many years, the GSEs were very profitable since
the implicit government guarantee enabled the GSEs to guarantee their MBS and to finance
their investment portfolios at lower cost than competitors. GSE profitability was increased
by their charter provisions such as those exempting them from state and local income taxes, Figure 1 – Precrisis Business Model of Fannie Mae and Freddie Mac
and by lower capital requirements than their non-GSE competitors (Weiss, Sep. 2013). In
return, they were obligated to fulfill their public mission for the benefits they received, which
included supporting affordable housing and underserved areas. When the private lenders
found it was more profitable and competitive in issuing nonprime mortgages, the nonprime
mortgage share of the private lenders increased significantly. The GSEs, in accordance with
its public mission set annually by the HUD, were forced to purchase these nonprime
mortgages. The purchase of nonprime mortgages counted toward meeting these goals
because the underlying mortgages tended to be made to less-than-median-income borrowers
or were collateralized by properties in “underserved areas” (Thomas & Van Order, 2011).
However, it is the nonprime mortgages that later became the time bomb of the subprime
crisis.
Furthermore, Fannie Mae and Freddie Mac’s regulation was structurally weak and ineffective.
Fannie Mae and Freddie Mac’s regulator, the Office of Federal Housing Enterprise Oversight
(OFHEO), did not have adequate tools and authority to set capital standard to constrain risk
behavior. Moreover, the OFHEO did not have the capital to resolve the GSEs once it failed,
which is the mechanism that bank regulators use to resolve failed institutions. Again, the
implicit government guarantee made Fannie Mae and Freddie Mac immune from close
supervision.
At last, weak risk management of Fannie Mae and Freddie Mac made the two GSEs unable to
cover the losses as the housing bubble hit. The business model that Fannie Mac and Freddie
When the market were good, the shareholders could gain profits on their investment, while
when the market were bad, the losses were transferred to the taxpayers. Their lack of
consideration on systemic risk of the housing market undoubtedly left the enterprises and
taxpayers in grave danger. 7 Additionally, the two GSEs were allowed to hold less adequate
capital against financial risks, leaving the institutions unprepared to absorb losses.
The collapse of Fannie Mae and Freddie Mac were destined because of their privileges
beyond other financial institutions and market principals. However, whatever the precrisis
business model is right or wrong, no one can deny the unshakable status of Fannie Mae and
Freddie Mac in constructing the American Dream. Before the decision of winding down the
two GSEs has been made, taking a look at the GSEs’ products that helped generations will
show us a larger picture.
Section 3 – The Products and Roles of The GSEs
Whenever and wherever in the mortgage market, the accessibility to long-term mortgages is
critical to promoting homeownership and market stability, and the role of the GSEs is crucial
to the mortgages.
The long-term, fixed rate, fully amortizing, freely prepayable mortgages are the unique
products of the U.S. housing finance system, fully supported by the GSEs. The long-term, fixed
rate, fully amortizing, freely prepayable mortgages are more accessible and stable than any
other mortgage products. First of all, more low-income and low median-income families can
access the mortgage since it requires a low down payment and monthly payment by fully
amortizing in the long run. Secondly, borrowers can refinance their mortgages freely when
there is falling interest and prepay the payments without penalties. Most importantly, the
fixed rate mortgages transfer the interest rate risk from the borrowers to the lenders,
protecting families from unexpected interest rate increases.
The long-term fixed rate
mortgage rate has declined
over time (see Chart 6). In
1985, both the 15-year fixed
rate mortgages and 30-year
fixed rate mortgages had a
mortgage interest rate more
than 10 percent. At that time,
Chart 6 - Fixed Rate Mortgage Rate Since 1985
0.00 2.00 4.00 6.00 8.00 10.00 12.00 14.00
Sources: Board of Governors of the Federal Reserve System,"H15, Selected Interest Rates"
15 Year Fixed
the two GSEs, especially Fannie Mae had just gone through a hard period of the economic
recession. And the homeownership rate went down a lot in the early 1980s. It was one of the
two periods that the U.S. homeownership rate greatly declined (see Chart 1). The other one
was the time when the recent housing bubble burst. During the past twenty years, the fixed
rate mortgage rate has been decreasing all the time with a slight rebound in 2006. It reached
the bottom in 2010, with a 4.27 percent interest rate for 15-year fixed rate mortgage and
4.86 percent interest rate for 30-year fixed rate mortgage, making the mortgage more
affordable for low-income families. As government-sponsored institutions, GSEs had the
liability to fulfill the federal government’s mission in supporting low-moderate families. The
GSEs basically reached the goal before 2001 in purchasing low and moderate single-family
residential mortgages (see Table 2).
Table 2 – GSEs Low and Moderate-Income Goal Performance
Year Low-Moderate Goal Low-Moderate Achieved Single-Family Only Low-Moderate Achieved (All Purchases)
1993 0.30 0.28 NA
1994 0.30 0.35 NA
1995 0.30 0.36 NA
1996 0.40 0.36 0.46
1997 0.42 0.36 0.46
1998 0.42 0.37 0.44
1999 0.42 0.39 0.46
2000 0.42 0.40 0.50
2001 0.50 0.40 0.52
2002 0.50 0.40 0.52
2003 0.50 0.41 0.52
2004 0.50 0.45 0.53
2005 0.52 0.43 0.55
2006 0.53 0.43 0.57
2007 0.55 0.40 0.56
Indeed, the GSEs have expended a substantial effort to provide “affordable lending” products
in recent years (Wachter, 2005). “Affordable lending” products are those mortgages or
programs which require low down payments and have large impacts for underserved groups
and areas. For example, Fannie Mae offers a Conventional 97 that allows for a 3 percent
downpayment, which is based on the lower of the home's appraised value or purchase price.
For borrowers who can meet certain underwriting standards, Fannie Mae also offers a low
down payment option available for properties owned by Fannie Mae called the HomePath
loan. It allows a borrower to purchase a Fannie Mae-owned property with as little as a 5
percent downpayment. Freddie Mac’s Affordable Seconds also provides a maximum 95
percent Loan-to-value to supplement their down payment, closing and financing costs,
prepaid and rehabilitation costs as a secondary financing tool. These GSEs’ products made
great contributions to promoting homeownership.
Fannie Mae and Freddie Mac have played an increasingly pivotal role in residential mortgage
debt outstanding. In 1990, the combined Fannie Mae and Freddie Mac share of residential
mortgage debt outstanding took 25.7 percent of the total residential mortgage debt
outstanding (see Table 3). This number climbed up to 46.7 percent in 2010. Fannie Mae and
Freddie Mac held or securitized more than 5 trillion dollars of residential mortgage debt
outstanding in 2010 (see Table 4). The success or failure of the two GSEs can almost
Table 3 – Enterprise Share of Residential Mortgage Debt Outstanding
Combined Enterprise Share Fannie Mae Share Freddie Mac Share
1990 25.7% 14.0% 11.7%
1991 28.5% 15.8% 12.6%
1992 31.9% 18.1% 13.7%
1993 34.3% 19.7% 14.7%
1994 35.0% 20.0% 15.0%
1995 35.8% 20.6% 15.2%
1996 36.6% 21.1% 15.4%
1997 36.6% 21.3% 15.2%
1998 38.9% 22.9% 16.0%
1999 40.9% 23.8% 17.1%
2000 41.5% 23.9% 17.6%
2001 44.7% 25.9% 18.9%
2002 45.5% 26.7% 18.8%
2003 46.3% 28.3% 17.9%
2004 43.2% 26.2% 17.0%
2005 40.0% 23.3% 16.8%
2006 38.8% 22.5% 16.4%
2007 41.4% 23.8% 17.6%
2008 44.4% 25.9% 18.5%
2009 46.6% 27.3% 19.2%
2010 46.7% 27.7% 19.0%
Table 4 – Total Mortgages Held or Securitized by Fannie Mae and Freddie Mac of Residential Mortgage Debt Outstanding, 1990-2010 (Unit: Million Dollars)
Fannie Mae Freddie Mac Combined Enterprises Residential Mortgage Debt Outstanding
1990 $404,703 $338,217 $742,920 $2,893,729
1991 $484,267 $386,209 $870,476 $3,058,425
1992 $582,563 $441,410 $1,023,973 $3,212,681
1993 $662,167 $494,727 $1,156,894 $3,368,360
1994 $708,402 $533,484 $1,241,886 $3,546,131
1995 $766,741 $566,469 $1,333,210 $3,719,233
1996 $835,225 $610,820 $1,446,045 $3,954,526
1997 $895,816 $640,406 $1,536,222 $4,200,416
1998 $1,051,658 $733,360 $1,785,018 $4,590,489
1999 $1,203,086 $862,326 $2,065,412 $5,055,445
2000 $1,316,844 $968,399 $2,285,243 $5,508,592
2001 $1,579,398 $1,150,723 $2,730,121 $6,102,611
2002 $1,840,218 $1,297,081 $3,137,299 $6,896,266
2003 $2,209,388 $1,397,630 $3,607,018 $7,797,171
2004 $2,325,256 $1,505,531 $3,830,787 $8,872,741
2005 $2,336,807 $1,684,546 $4,021,353 $10,049,205
2006 $2,506,482 $1,826,720 $4,333,202 $11,163,068
2007 $2,846,812 $2,102,676 $4,949,488 $11,954,031
2008 $3,081,655 $2,207,476 $5,289,131 $11,906,478
2009 $3,202,041 $2,250,539 $5,452,580 $11,707,666
2010 $3,156,192 $2,164,859 $5,321,051 $11,387,676
Section 4 – The Conservation of The GSEs
After the overheating of the housing and mortgage market the late 1990s to 2006, the
housing and mortgage market took a sudden turn and became worse rapidly. The GSEs,
whose major business was mortgage purchase and guarantee, were not able to avoid the fate
of collapse. The U.S. government quickly reacted to the GSEs’ loss in order to protect the
numerous taxpayers and creditors – who had purchased mortgages issued or guaranteed by
Fannie Mae and Freddie Mac.
In 2008, the Housing and Economic Recovery Act (HERA) was enacted to provide needed
housing reform guidance. HERA established the Federal Housing Finance Agency (FHFA) as
an independent agency of the Federal government to reinforce the regulation and
supervision of the GSEs. The advantage of the FHFA over the former regulator OFHEO
consisted in the FHFA absorbed the powers and authority of several entities, including the
Federal Housing Finance Board (FHFB), OFHEO, and the HUD GSE mission team, expanding
its ability to place the GSEs into receivership or conservation.
At the same time, the Act set up improvements of supervision missions to offset the flaws in
the precrisis business model of the GSEs. It established a public use database and opened
mortgage data report to improve the transparency of the enterprise operation. It reset the
affordable housing goal and duty to serve underserved markets to ensure the GSEs would not
be forced to purchase nonprime mortgages to reach their goals. More importantly, it limited
the loan to value of each mortgage and set up maximum limits for conforming loans for
adequate loans within their ability to pay back the debt. Typically, a mortgage secured by a
single-family residence shall not exceed $417,000, a mortgage secured by a 2-family
residence shall not exceed $533,850, a mortgage secured by a 3-family residence shall not
exceed $645,300, and a mortgage secured by a 4-family residence shall not exceed $801,950.
Another important action to GSE conservation is the establishment of Senior Preferred Stock
Purchase Agreements (PSPAs) based on Generally Accepted Accounting Principles (GAAP),
which rules that whenever an Enterprise’s liabilities exceed its assets, the Treasury provides
sufficient cash to ensure the Enterprise maintained solvency. In exchange for Treasury’s
funding commitment, the Enterprises were required to provide Treasury senior preferred
stock, quarterly dividends, warrants to purchase 79.9% of each Enterprise’s common stock,
and commitment fees (Federal Housing Finance Agency Office of Inspector General, 2013).
Each Enterprise is required to pay to the U.S. Department of the Treasury a quarterly
dividend equal to 10 percent of the total amount drawn under their respective agreements.
Meanwhile, the terms of the agreements require a 10 percent reduction in the Enterprises'
retained portfolios each year to further reduce risk exposure and simplify the operation of
Fannie Mae and Freddie Mac.
Under the PSPAs, the U.S. Treasury received senior preferred stock with a stated value of 2
billion dollars. The cumulative draws from Treasury commitments to finance Fannie Mae and
Freddie Mac have reached 187.485 billion dollars until the third quarter in 2013(See Table
189.485 billion dollars if the Enterprises are liquidated (Federal Housing Finance Agency
Office of Inspector General, 2013).
Table 5 – Quarterly Draws on Treasury Commitments to Fannie Mae and Freddie Mac per the Senior Preferred Stock Purchase Agreements ($ billions)
Fannie Mae Freddie Mac
Quarter GAAP Net
Worth Requested Draw Cumulative Draws GAAP Net Worth Requested Draw Cumulative Draws
2008 Q3 9.4 0.0 0.0 -13.7 13.8 13.8
2008 Q4 -15.2 15.2 15.2 -30.6 30.8 44.6
2009 Q1 -18.9 19.0 34.2 -6.0 6.1 50.7
2009 Q2 -10.6 10.7 44.9 8.2 0 50.7
2009 Q3 -15.0 15.0 59.9 10.4 0 50.7
2009 Q4 -15.3 15.3 75.2 4.4 0 50.7
2010 Q1 -8.4 8.4 83.6 -10.5 10.6 61.3
2010 Q2 -1.4 1.5 85.1 -1.7 1.8 63.1
2010 Q3 -2.4 2.5 87.6 -0.1 0.1 63.2
2010 Q4 -2.5 2.6 90.2 -0.4 0.5 63.7
2011 Q1 -8.4 8.5 98.7 1.2 0 63.7
2011 Q2 -5.087 5.087 103.787 -1.478 1.479 65.179
2011 Q3 -7.791 7.791 111.578 -5.991 5.992 71.171
2011 Q4 -4.571 4.571 116.149 -0.146 0.146 71.317
2012 Q1 0.268 0 116.149 -0.019 0.019 71.336
2012 Q2 2.77 0 116.149 1.086 0 71.336
2012 Q3 2.412 0 116.149 4.906 0 71.336
2012 Q4 7.224 0 116.149 8.826 0 71.336
2013 Q1 59.368 0 116.149 6.971 0 71.336
2013 Q2 13.243 0 116.149 7.357 0 71.336
2013 Q3 11.616 0 116.149 33.436 0 71.336
Cumulative Draw by Both Enterprises 187.485
Sources: FHFA, Market Data, Current Data on Treasury and Federal Reserve Purchase Programs for GSE and Mortgage-Related Securities
In the first four years under the PSPAs, from 2008 to 2011 the two GSEs’ quarterly GAAP net
worth were mostly negative, and this was especially true for Fannie Mae, which suffered
from losses for thirteen continuous quarters (from 2008 Q4 to 2011 Q4). With the financial
net worth turned positive in 2012 and became even better in 2013. The Treasury no longer
paid for the GSEs’ net loss when the GSEs did not have a deficit.
In terms of the quarterly dividends paid for the Treasury, the dividends accrued started at 6
million dollars for both Enterprises in the third quarter in 2008. The number gradually
became larger and
larger as the situation
of the two GSEs got
better. The financial
gap between their
quarterly draws and
dividends decreased
during time (see Chart
7). In 2012, Fannie
Mae and Freddie
Mac’s quarterly
dividends paid to the
Treasury exceeded their draws from the Treasury. As of December 31, 2013, Fannie Mae and
Freddie Mac had paid back the Treasury 185.224 billion dollars in total, which is almost the
same amount as the Treasury’s financial support (see Table 6). But Fannie Mae and Freddie
Mac’s operation statues were better off by gaining a positive net worth in the most recent
periods. The Treasury could continuously receive benefits after their financial support Chart 7 – Quarterly Gap between Enterprises
Draws and Dividends ($billions)
Sources: FHFA, Market Data, Current Data on Treasury and Federal Reserve Purchase Programs for GSE and Mortgage-Related Securities
-40 -20 0 20 40 60 80
2008 Q3 2008 Q4 2009 Q1 2009 Q2 2009 Q3 2009 Q4 2010 Q1 2010 Q2 2010 Q3 2010 Q4 2011 Q1 2011 Q2 2011 Q3 2011 Q4 2012 Q1 2012 Q2 2012 Q3 2012 Q4 2013 Q1 2013 Q2 2013 Q3 2013 Q4
amount is paid back. At this time, the implicit government guarantee has become explicit.
And Fannie Mae and Freddie Mac survived through the conservation.
Table 6 – Dividends on Enterprise Paid for Treasury ($billions)
Fannie Mae Freddie Mac
Quarter Dividends Accrued Cumulative
Dividends Paid Dividends Accrued Cumulative Dividends Paid
2008 Q3 0.006 0.006 0.006 0.006
2008 Q4 0.025 0.031 0.167 0.173
2009 Q1 0.025 0.056 0.370 0.543
2009 Q2 0.409 0.465 1.149 1.692
2009 Q3 0.885 1.350 1.294 2.986
2009 Q4 1.150 2.500 1.293 4.279
2010 Q1 1.527 4.027 1.293 5.572
2010 Q2 1.909 5.936 1.293 6.865
2010 Q3 2.117 8.053 1.560 8.425
2010 Q4 2.153 10.206 1.603 10.028
2011 Q1 2.216 12.422 1.605 11.633
2011 Q2 2.281 14.703 1.618 13.251
2011 Q3 2.495 17.198 1.618 14.869
2011 Q4 2.621 19.819 1.655 16.524
2012 Q1 2.819 22.638 1.808 18.332
2012 Q2 2.931 25.569 1.808 20.140
2012 Q3 2.929 28.498 1.808 21.948
2012 Q4 2.929 31.427 1.808 23.756
2013 Q1 4.224 35.651 5.826 29.582
2013 Q2 59.368 95.019 6.971 36.553
2013 Q3 10.243 105.262 4.357 40.910
2013 Q4 8.616 113.878 30.436 71.346
Cumulative Dividends Paid by Both Enterprises 185.224
Section 5 – The Prospects of The GSEs
Five years have passed since the federal government’s takeover of the GSEs. The future of the
GSEs has been an issue of concern among millions of U.S. taxpayers. Some experts cited
Fannie Mae and Freddie Mac’s inefficient function in the housing market, and concluded that
once the housing and financial markets recover from the recent turmoil, shutting down
Fannie Mae and Freddie Mac would have, at most, a minimal impact on the overall housing
market (Ligon, 2013). Others pinpointed the indispensable position of the two GSEs, arguing
that without an adequate supply of mortgage finance from Fannie and Freddie, the housing
market’s decline would likely have been far deeper, with even more dire consequences for
the overall economy (England, 2010). Peter J. Wallison, a fellow in Financial Policy Studies at
the American Enterprise Institute (AEI), explains that many observers do not believe the two
GSEs can survive the immense losses they will cause taxpayers, but this is far from true
(Wallison, 2010). More importantly, there is not even a hint of a new mortgage financing
system that can replace the GSEs’ system. In light of the central role that the GSEs played and
still play today, every step on the future role of the GSEs should be cautious.
Three Possible Approaches for Fannie Mae and Freddie Mac
Most proposals have identified three possible approaches for the future of Fannie Mae and
Freddie Mac – a hybrid public/private model, a fully federal agency, and a fully private
secondary mortgage market without Fannie Mae and Freddie Mac.
Many proposals for the secondary mortgage market put forward a hybrid model that
combines private for-profit or nonprofit firms and federal government guarantees on
qualifying MBSs. The hybrid public/private model preserves many features of the precrisis
model, but it would differ from the precrisis model in several significant aspects. One of the
most important differences would be the transformation of the implicit federal government
guarantee to an explicit federal government guarantee, and their subsidy cost would be
recorded in the federal budget. As mentioned, the weakness of the implicit federal
government guarantee lies in offering GSEs many privileges while invading and violating the
market rules without compensating the market. An explicit federal government guarantee
would measure the guarantee effects in terms of money and could require the GSEs to pay
back a reasonable amount if the guarantee is recorded. During the conservation period, the
Treasury has committed to provide funding to GSEs’ operation as an explicit federal
government guarantee in order to maintain their solvency. In return, dividends were paid
back to the Treasury and a 10 percent reduction in the Enterprises' retained portfolios each
year was committed. The explicit guarantee did not make too much burden for the federal
government as it was mostly paid back, in other words, it did not put too much risk for
taxpayers, while the GSEs’ situation became better.
The advantage of a hybrid model is obvious in several ways. First of all, like the precrisis
model, an explicit federal government guarantee would ensure accessibility and liquidity in
the secondary market. As many professionals have worried, without a government guarantee,
the mortgage market would not be able to provide enough accessibility for low and median
supported in the mortgage market without a government guarantee. Compared with the
precrisis model, imposing recorded guarantee fees would ensure that taxpayers received
some compensation for the risks they were assuming (Congressional Budget Office Financial
Analysis Division, 2010).
However, a hybrid public/private model would still suffer from the contradiction of pursuing
affordable housing goals to fulfill a public mission and making maximum profits to serve
private shareholders in the precrisis model. Additionally, the government would have
trouble setting risk-sensitive prices for guarantees and it would be hard to find an exact
balance in distributing some risks to the GSEs or shifting some risks to taxpayers.
A Fully Federal Agency
Another approach of a fully federal agency would not be the same model before 1968 when
the GSEs’ financial operation fully depended on federal budget. In contrast, this alternative
would rely on private institutions created by the federal government to guarantee and
securitize qualifying mortgages. By providing explicit protection against default risk to
investors, the cost of the program could be fully or partially covered by charging guarantee
fees. The fully federal agency model would enable Fannie Mae and Freddie Mac to continue
buying mortgages from originators and securitizing them. The main difference is that they
would be prohibited from holding mortgage portfolios.
The advantage of a fully federal agency is that it would ensure enough funds flow into the
agency model would be more easily controlled compared with the hybrid public/private
model since it would not be essential to serve the private shareholders. Furthermore,
guarantee fees could be adjusted to control the size of various kinds of mortgage portfolios.
The federal agency could give a lower guarantee fees to low-income families and
underserved areas as a political preference towards the disadvantaged groups.
A fully federal agency model would limit Fannie Mae and Freddie Mac’s revenue resources to
guarantee fees. The guarantee fees could be quite high if the federal agency wants to be
financial independent, which may be unbearable for many originators. However, if the
federal agency model maintains low mortgage guarantee fees as Fannie Mae and Freddie Mac
did before, the federal agency would probably need financial support from the federal
government, imposing significant credit risk to taxpayers. Therefore, it violates the
fundamental principal of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank) that protects the benefits of the taxpayers. For these reasons, a fully federal
agency model may not be the best choice for the future of the GSEs at this moment.
A Fully Private Secondary Mortgage Market
Some observers have proposed completely privatizing the secondary mortgage market and
shutting down Fannie Mae and Freddie Mac. Under that approach, there would be no federal
government guarantees of MBSs or debt securities. The federal government could wind
down Fannie Mae and Freddie Mac, sell their assets in pieces or sell the enterprises as a
secondary mortgage market and provide the private sector a fully competitive mortgage
market.
To realize a fully private secondary mortgage market, requires a significant departure from
the status quo of the GSEs because Fannie Mae and Freddie Mac played an even more
dominant role in the mortgage market since conservation. The federal government could
start with stopping the explicit guarantee and eliminating the dominant effect of government
guaranteed mortgages. If Fannie Mae and Freddie Mac no longer had the advantage of federal
backing, other large financial institutions could compete with Fannie Mae and Freddie Mac in
a securitization market. When the mortgage market reaches a more balanced situation those
financial institutions other than Fannie Mae and Freddie Mac take a steadily large portion of
the mortgages, the federal government could break up or liquidate Fannie Mae and Freddie
Mac to accelerate the privatization process. More private sector firms would be able to join
the secondary mortgage market if the two giants were broken up. Finally, the secondary
mortgage market would be dominated by the private sector and form a fully private
mortgage market without Fannie Mae and Freddie Mac.
The privatization of the Fannie Mae and Freddie Mac would increase competition in the
secondary mortgage market. On one hand, competition may cause the private sector to take
too much risk as they did in the subprime mortgage crisis. On the other hand, competition
would reduce the market’s reliance on one or two firms, leading to a reduction of systemic
risk caused by the GSEs. A private secondary market would ensure that the private sector
public/private model and the fully federal agency model. A private secondary mortgage
market would reflect a more accurate mortgage rate relating to the housing market, credit
records and down payments. A private mortgage market without government guarantees
does not mean that it is a market without government intervention. On the contrary, more
specific regulations should be made to require private sectors to check and understand the
borrowers’ ability to repay the debt, to ask private sectors to take full responsibility to
consider the best kind of mortgages for borrowers to reduce the risks for both sides. In fact,
the Dodd-Frank has regulated qualified residential mortgages (QRMs) as a loan that aims to
minimize the borrower’s risk and control default rate. For non-QRM loans sold into the
private secondary market, mortgage lenders must retain a portion of the loan’s risk.
The disadvantage of a private secondary market can be seen in several aspects. One potential
problem of the fully private mortgage market is that the private sector, which pursues the
maximum profits, does not care about and would probably not provide special assistance to
low and median income borrowers and underserved areas. It is hard for federal or local
governments to ask the private sectors to give special privileges to low-income groups.
Affordable housing goals would be more difficult to implement without federal government
support. The federal government may need to find other intermediaries to support
affordable housing programs that are currently channeled through Fannie Mae and Freddie
Mac. Unlike a fully federal agency, a private secondary mortgage market is less adjustable
and controllable if the housing market goes down. A fully risk management mechanism
The future of the GSEs will have a dominant role in determining the secondary mortgage
market. Three possible approaches for the future of the GSEs have their merits and
drawbacks (see Table 7). Even though, a fully federal agency may not be a best way
compared with a hybrid public/private model and a fully private secondary market model at
this moment, there is no sound evidence that demonstrates any certain model would ensure
an accessible, stable, and sustainable secondary mortgage market for all taxpayers. Now is
the time to think about a detour to regain the dream – promoting homeownership and
providing affordable housing to Americans. Stepping out of the secondary mortgage market
Table 7 – Decision Matrix of Different Influence on Various Parties Based on the GSEs’ Possible Approaches
A Hybrid Public/Private Model A Fully Federal Agency A Fully Private Secondary Mortgage Market
Affected Parties Positive Negative Positive Negative Positive Negative
Federal Government
Explicit guarantees can be recorded in the federal budget so that federal
government can gain revenues from the guarantees; as a hybrid
public/private enterprise, the federal government can be easier to carry out public missions.
It may be hard to calculate the explicit guarantees and set the risk-sensitive prices for guarantee fees.
Federal government can fully control the agency and carry out public mission without serving the private shareholders.
A fully federal agency may narrow its business to guarantee business, which may yield a high guarantee fees; the federal government may need to support their business if they want to keep the guarantee fees affordable.
Federal government does not involve any financial support; they can still regulate the market by regulations and laws.
Affordable housing goals and
underserved areas are hard to be addressed in a fully private secondary mortgage market; federal government may loss support from the weak groups.
Taxpayers (See Borrowers)
Taxpayers may still be exposed to credit risk because of federal government’s guarantee on GSEs’ business.
(See Borrowers)
Taxpayers are exposed to credit risk if the federal
government decides to support the guarantee business.
With no financial support from the government means the federal
government does not use the taxpayers’ money to support the market. (See Borrowers) Private Financial Institutions Private financial institutions may be better off for the GSEs would pay for the explicit privilege they have.
Private financial institutions are still in a week position because federal government does not back up their MBS business.
Private financial institutions can expand their mortgage business by purchasing and holding more MBS.
To attract investors, they may need to pay higher guarantees fees to get federal
government
guarantees compared to the hybrid model.
Private financial institutions can compete equally in a fully competitive market.
Competitive
sometimes may lead to serious
consequences like the wide spreading of the Subprime and Alt-A mortgages.
Borrowers
Government involving in the mortgage market can ensure the liquidity, accessibility and affordability of the mortgage at all times.
(See Taxpayers)
Government involving in the mortgage market can ensure the liquidity, accessibility and affordability of the mortgage at all times.
(See Taxpayers) (See Taxpayers)
Section 6 – Conclusion
The GSEs’ role has changed over time. Whatever and whenever their role was, they played
a pivotal role in the secondary mortgage market and exercised a tremendous influence on
the U.S. housing market. It is ironic that the GSEs was a vital factor of the success of the U.S.
housing finance system for a long time since their establishment, in the meanwhile they
took great responsibility for the subprime mortgage crisis and housing bubble in recent
years. The prospects of the GSEs greatly affect the housing market, mortgage market and
macroeconomic in the United States. Every step towards the future of the GSEs should be
paid with great attention and caution.
The three possible approaches indicate the alternatives of the GSEs’ future. However, based
on present analysis, none of them gives a perfect solution that can make sure a bright
future of the housing and mortgage market with or without GSEs’ existence. No matter
what approach the federal government chooses, it will not make sure the market would
follow exactly the same pattern as the federal government’s expectation. However, Fannie
Mae and Freddie Mac’ transformation from the entire federal agency model to the
public/private agency model so far has not been sustainably successful. Furthermore, one
of the fundamental points in the future is that the GSEs should not cause further potential
losses to taxpayers after they have repaid the creditors. A fully private secondary mortgage
market may be a more reliable way to avoid the reoccurrence of the flaws in the precrisis
model, which is consistent with decision from the 2013 Corker-Warner Housing Finance
The Housing Finance Reform and Taxpayer Protection Act decided to wind down Fannie
Mae and Freddie Mac within five years. Instead, the federal government will create the
Federal Mortgage Insurance Corporation (FMIC) to take part of the GSEs’ functions. In
order to eliminate the drawbacks of a private secondary mortgage market, the Act specifies
the FMIC would only guarantee losses in excess of 10 percent, a threshold intended to
require private investors to fully bear losses well beyond those observed during the 2008
financial crisis. The federal government guarantee would only be effective when the market
suffers from a catastrophic scenario to make sure the liquidity and stability of the mortgage
market. The more recent Johnson-Crapo bill repeals mandatory affordable housing goals
the Congress enacted in the early 1990s, but charges borrowers a 10 basis point premium
dedicated to three affordable housing funds to support affordable housing and make up the
weakness of underserving low-income families in a private market. Future reforms on GSEs
and the mortgage market should emphasize more on the numbers and percentages
involved in these reforms. For example, what percentage of downpayment for the QRM can
maximize the utility of the mortgage that reduces the risk while ensures the most
accessibility at the same time. Additionally, the federal government should ask questions
like would a 10 percent guarantee for the losses be the best for private investors to take the
most responsibility while it can ensure the ongoing of the secondary mortgage market at all
times. Therefore, whatever the decision has been made on the GSEs and the mortgage
market at the moment, the federal government should keep focusing on the reaction of the
market to any GSEs’ future approach, and make appropriately corresponding actions to
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